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I have a big doubt in IAS 2 inventory valuation method.
IAS 2 states that inventory should he valued at lower of cost or net realisable value.
Prudence concept states that all losses should be included but profit will be only included when realised.
But neither of the marginal or absorption costing completely follows prudence concept.
In marginal costing selling variable cost are included in inventory valuation which increases profit for the period by that amount.
In absorption costing also, fixed overheads increases profit by the amount of fixed overhead included in closing inventory.
According to IAS absorption costing is followed. So my doubt is if IAS 2 ignores prudence concept or not ?IAS2 is of no relevance to Paper F2 at all, because F2 is management accounting. Accounting standards do not apply to management accounting – there are no ‘rules’ in management accounting, because management accounting is purely to help management make decisions and is internal. IAS’s/IFRS’s only apply to financial reporting because it is external.
In management accounting we do not apply the lower of cost and net realisable value rule – we do not consider the NRV but value inventories at the cost of production. Whether we choose to use marginal or absorption costing in management accounts is our choice – for decision making, marginal is usually more useful; for deciding on a selling price then absorption is usually more useful. (In the exam of course we do what we are told 🙂 )
Actually i am studying F3 only but i thought this question will be relevant to F2. Anyways ..so when we consider IAS2 in financial reporting, is it he case that IAS2 ignores prudence concept ?
I will answer you, but in future ask in the F3 forum 🙂
Apart from the fact that we value inventory at the lower of cost and NRV, the prudence concept is not relevant.
Two things:
Firstly, if NRV is not lower than cost, then it means we expect to sell at a profit, but the profit will be selling price less all costs (not the contribution – i.e. selling price less marginal cost). There is no loss to recognise.
Secondly, the closing inventory valued using absorption costing will indeed be higher than closing inventory valued using marginal costing, and therefore the profit will be higher this year. However, this years closing inventory will be next years opening inventory which will mean absorption costing will give a lower profit next year. In the long-run the profits will be the same whichever method is used (provided obviously we are consistent in the method we use).
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